I’ve posted Entry #228 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Fair-Value P/E10 Number Can Change (Slightly) Over Time.
Juicy Excerpt: A huge benefit of the new strategy is the discipline that it imposes on the investor. Investors following Buy-and-Hold strategies tend to be self-congratulatory when prices increase by 30 percent. They elected to follow a strategy that always calls for large stock allocations and they were rewarded (temporarily) by the market for doing so. The feedback they are receiving is telling them that they have this investing thing figured out! Investors in those circumstances don’t feel much of a need to look too closely into the question of whether those 30 percent gains are truly justified.
In contrast, Valuation-Informed Indexers start with a default belief that the market value should only increase by 6.5 percent real each year. They can of course go with some other assumption if they choose. There is no rule that says that a Valuation-Informed Indexer cannot decide for himself that the fair-value P/E10 number has risen to 17 percent or 18 percent or whatever. Still, the default belief in a 6.5 percent return grounds the process of assessing how much stock returns have increased in something real. When you are acting on a belief that stock returns cannot be known in advance, a 30 percent gain is not entirely shocking — it’s a big gain but the numbers say what the numbers say! A Valuation-Informed Indexer understands that the U.S. economy could grow sufficiently productive to support an annual gain of 7 percent or perhaps 8 percent but is highly suspicious of numbers showing a 30 percent gain. That’s a healthy skepticism!